Fundamentals boiled down to QE or QT since 2009. Now there’s lots of QT, globally, to battle the worst inflation in decades.
By Wolf Richter. This is the transcript of my podcast on Sunday, October 1, THE WOLF STREET REPORT.
A big part of Wall Street and stock market jockeys, and bond-market gurus, queens, and kings, have variously predicted, clamored for, or begged for a big-fat recession. Ever Since about June 2022, they want that big-fat recession because it would “force” the Federal Reserve to pivot, to cut rates, to end Quantitative Tightening, and to restart quantitative easing – the good ol’ money printing.
And this clamoring for a big-fat recession is still going on. The recession-mongers have fanned out and they’re everywhere doing a lot of heavy breathing. And it’s still going on because bets on the stock market went sour.
The Nasdaq is now down by over 18% from its peak in November 2021. The S&P 500 index is down 11% since its peak in January 2022. I mean, how could stocks be even allowed to drop?
Stocks ran out of steam in late 2021 when the Fed started talking about higher rates, ending money-printing, and eventually start the opposite of money-printing, quantitative tightening. By the time money-printing ended and the Fed hiked its policy rates in March 2022, stocks had already dropped a bunch.
They didn’t drop because the economy was bad, far from it. They dropped because money printing and interest rate repression had fueled this huge run-up since 2009. Free money makes all things possible.
In 2018, the Fed gingerly engaged in quantitative tightening, and the S&P 500 dropped nearly 20%. So we know that works.
Stock prices balloon under money-printing and deflate under quantitative tightening. That has by now been established.
This was further confirmed by another bout of that in March through July this year. In March several regional banks collapsed, not because of their loans going bad, which was the problem during the Financial Crisis, but because bond prices had plunged because market yields had soared, which scared the bejesus out of their depositors who then yanked their money out, creating the biggest fastest run-on-the-bank ever, and the banks were history in no time, and other banks were getting lined up against the wall to be shot as well.
So the Fed and the FDIC stepped in to bail out depositors, not investors. Investors got dismembered. And for the Fed it meant throwing about $400 billion in short-term liquidity at the banking system in no time, and that $400 billion in liquidity had the effect that stocks suddenly rocketed higher.
But the Fed continued shedding its securities, and then it drained out the liquidity it had sprayed at the banks, and this turned into the fastest quantitative tightening ever, and by July the show was over. In August, stocks fell, and in September they fell a lot more.
This stock market rose from 2009 to incredible highs in 2021, fueled by money printing, many trillions of dollars over the years, and near-zero policy interest rates.
This was a global phenomenon, with all major central banks doing the same thing, money printing and interest rate repression.
But then the worst inflation kicked off in early 2021, and eventually central banks responded to put a lid on it. And so here we are: massive global QT and much higher rates, promised for much longer. The Bank of Japan is the only exception. And the US economy is still plugging along just fine.
At these astronomical levels of the stock market – still astronomical despite the declines so far – stock prices cannot handle quantitative tightening. Stocks had been driven higher by money printing, and now we have the opposite, global quantitative tightening, and stocks are heading lower.
That’s why Wall Street is clamoring for a big-fat recession: They’re hoping it would “force” the Fed to end QT and restart QE. But the Fed is battling inflation, and it has now also figured out what its asset purchases, its money-printing orgy, have accomplished, and it lost its appetite for it.
And bets on long-term bonds have turned horribly sour. Just look at long-term Treasury bond funds to see the carnage. Those were marketed as a conservative yield investment.
The iShares 20-plus-year Treasury bond ETF, with the ticker of TLT, is down nearly 50% from the peak in August 2020, which marked the peak of the 40-year bond bull market, which had turned into a bond bubble. Since then, bond yields have risen and bond prices have fallen.
Back in mid-August 2020, the government sold 30-year Treasury securities at auction at a yield of 1.4%. Now the 30-year yield is at 4.7%, and the 30-year Treasuries that these investors bought in August 2020 have now lost about half their value in the market. Investors will not have a capital loss if they hold these securities to maturity in August 2050, and they’ll collect 1.4% in interest every year along the way. But if they try to sell today, they’ll lose about 50%.
New investors might like to buy those bonds because now they come with lower prices and a nice 4.7% yield. But investors that bought those bonds three years ago are getting crushed.
At the same time, short-term Treasury bills have gotten very popular with their high yields, now at around 5.5%, and their small downside. But investors in long-term Treasury securities and corporate bonds have gotten crushed.
For bond-fund managers, this is a horror show. That’s why they’re clamoring for a big-fat recession: they want the Fed to cut rates, and end Quantitative Tightening, and they want the Fed to restart money printing so that their bond funds can recover.
But the Fed is fighting the worst inflation in decades, which was in part caused by the Fed’s policies of years of money printing and interest rate repression.
Commercial real estate acts the same way as bonds. When yields rise, prices of fixed-income instruments and commercial real estate fall by definition. That part is inevitable.
Commercial real estate is in trouble. CRE investors are losing their shirts, just like holders of long-term bonds. Landlords face suddenly much higher interest rates that make their variable-rate mortgages economically infeasible, and that make it impossible to refinance a maturing fixed-rate mortgage because the current rent won’t cover the new interest payments. So landlords have walked away from their mortgages and have let the creditors take those properties and the losses. And as we are finding out on a daily basis now, many of these lenders are investors in Commercial Mortgage-Backed Securities and mortgage REITs, rather than banks.
Landlords and lenders in the office sector have the additional issue of the rug getting pulled out from under their office towers by working-from-home and the corporate recognition that they don’t need this much office space. A stunning amount of the office space in central business districts is now vacant and available for lease or sublease. In a bunch of cities, these availability rates are near or above 30%.
Investors in shopping malls have been in trouble since about 2017 due to the ongoing brick-and-mortar meltdown, as I called it, brought on by Americans switching massively to ecommerce for their shopping. Landlords have walked away from numerous malls, letting lenders – again mostly investors in commercial mortgage-backed securities rather than banks – take the losses.
Even the biggest retail landlords, Simon Property Group and Brookfield, have walked away from malls, and Westfields is getting rid of its entire portfolio of malls in the US, either by walking away or by selling them. It got that process started by walking away from two malls in Florida in 2020 and 2021.
But don’t blame the economy. Bonds and stocks are not dropping because the economy is bad. The economy has been muddling through at about the pre-pandemic pace, and in the third quarter, it appears to have picked up some steam. Unemployment rates and unemployment claims are near historic lows. Tech hiring resumed despite all the breathless news about layoffs that sort of fizzled out earlier this year.
Consumers have been surprisingly eager and able to spend money, and they’ve been outspending inflation despite the much higher interest rates. They’ve gotten the biggest pay increases in 40 years, and they’re working in record numbers, and now they’re earning lots of interest on their trillions of dollars in CDs, savings accounts, money market funds, and Treasury bills, and they’re spending money hand over fist. I’ve been calling them drunken sailors all year.
Businesses are investing and spending. And the government is the biggest drunken sailor of them all, with its gigantic $2-trillion deficit spending during what are the Good Times.
So the economy has been plugging along at a pretty decent pace – and seems to be accelerating.
But prices of stocks, long-term bonds, and commercial real estate have dropped. They have dropped because there has been an epic change in the regime of monetary policies.
For stocks at these still ridiculously high levels, QT is toxic. Stocks need money-printing to rise from here. They got $400 billion this spring from the Fed, and stocks jumped, and then the Fed drained these $400 billion back out, and it drained another $300-billion-plus out since then, and it continues to drain liquidity and shed assets from its balance sheet, and stocks have been swooning since early August.
There is a direct connection between asset prices and money printing. QE inflates asset prices, and a lot of QE for about 13 years off and on inflated stock prices beyond recognition. Even modest QT, as we have seen in 2018, caused stock prices to tank. But back then, inflation was at or below the Fed’s target, and it was easy for the Fed to end QT.
But now there is a lot of inflation, and the whole game has changed, and all prior assumptions are out the window. And now there’s a lot of QT, and so stock prices are deflating, and other asset prices are deflating. There is no magic here. There was no magic in the run-up of stock prices either – it was QE; and now that there’s QT, it’s not magic either. Those are the fundamentals of the stock market now: QE or QT, until stock prices get down to some reasonable level, when other fundamentals start playing a role again. This was the transcript of my original podcast on Sunday, October 1, THE WOLF STREET REPORT.
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